Economics Chapter 3: Money and Credit

Facts that Matter

  1. Money acts as an intermediate in the exchange process and therefore it is called a medium of exchange.
  2. In our day to day transactions, goods are being bought and sold with the use of money. At times we do exchange services with money.
  3. Use of money has made things easier to exchange as we can exchange it for any commodity we need.
  4. The main function of money in an economic system is to facilitate the exchange of goods and services.
  5. In a barter system, commodities are exchanged with commodities without the use of money. But both parties have to agree to sell and buy each other’s commodities. This is called double coincidence of wants. But the use of money eliminates the need for double coincidence of wants.
  6. Money acts as a medium of exchange in transactions. In the earlier times, before the introduction of coins, a variety of objects was used as money. For example, grains and cattle, metallic coins—gold, silver, copper coins.
  7. Modern forms of money include currency—paper notes and coins. It is not made of precious metals as gold, silver, copper. It is accepted as a medium of exchange because the currency is authorised by the government of India.
  8. RBI issues notes on behalf of the central government. The law legalises the use of rupee as a medium of payment that cannot be refused in settling transactions in India.
  9. People deposit money with the banks which they don’t need at a point of time by opening a bank account in their name. Banks accept the deposits and also pay an amount of  interest on the deposits.
  10. The deposited money in bank can also be withdrawn at the depositor’s wish. Since the deposits in the bank accounts can be withdrawn on demand, these deposits are called demand deposits.
  11. It offers a facility i.e. the payments made by cheques. A cheque is a paper instructing the bank to pay a specific amount from the person‘s account to the person in whose name the cheque has been issued. The facility of cheques against demand deposits makes it possible to directly settle payments without the use of cash.
  12. Banks keep only a small proportion of their deposits as cash with themselves, as a provision to pay the depositors who might come to withdraw from the bank on any given days.
  13. Banks use their major portion of the deposits to extend loans; there is huge demand of loans for various economic activities.
  14. Banks mediate between those people who have surplus funds (depositors) and those who are in need of those funds (the borrowers).
  15. Banks charge higher rate of interest on the loans than what they offer on deposits. The difference between what is charged from borrowers and what is paid to depositors is their main source of income.
  16. The banks play an important role in the economy of a country by providing cheap loans to a large number of people.
  17. Banks employ a large number of people and thus they solve the problem of unemployment to a great extent.
  18. Banks are sometimes not willing to lend to certain borrowers because some persons are not able to produce certificate of their earning. There are some people who have a history of non-repayment of loans. There are other people who are not able to produce documents of their employment. Some persons have nothing to give to bank as collateral.
  19. A large number of transactions in our day to day activities involve credit in some form or the other. Credit refers to an agreement in which lender supplies the borrowers with money, goods and services in return for the promise of future payments.
  20. In the rural areas the main demand for the credit is for the crop production.
  21. Farmers usually take crop loans at the beginning of the season and repay loan after harvest. Repayment of the loan is dependent on the income from farming.
  22. If the harvest is poor, the repayment of the loan becomes difficult and credit instead of improving the earnings, pushes the borrower into a situation from which recovery is very difficult and painful. This situation is called debt-trap. Then the borrower is forced to give up his collateral or asset used as the guarantee to the lender.
  23. Terms of credit such as interest rate, collateral, etc. vary substantially from one credit arrangement to another. They may vary depending on the nature of the lender and borrower. Every loan agreement specifies an interest rate which the borrower has to pay to the lender along with the repayment of the principal. In addition to this, lenders may demand collateral (security) against the loans.
  24. People obtain loans from Formal and Informal sectors. Formal sectors include banks and cooperatives.
  25. Reserve Bank of India (RBI) supervises the functioning of formal sources of loans.
  26. Informal sectors include money lenders, traders, employers, relatives and friends etc. There is no one to supervise their credit activities. It can charge whatever interest rate they choose. There is no one to stop them from using unfair means to get their money back.
  27. Compared to the formal lenders most of the informal lenders charge a much higher interest on loans.
  28. Higher cost of borrowing means a larger part of earnings of the borrowers is used to repay the loan and they have less income left for themselves.
  29. For these reasons banks and cooperatives need to lend more and expand formal sources of credit in India. This would lead to higher incomes and many people could then borrow cheaply for a variety of needs. Cheap and affordable credit is important for the country’s development.
  30. At present it is the richer households who receive formal credit whereas the poor have to depend on the informal sources. It is important that the formal credit is distributed more equally so that the poor can benefit from the cheaper loans.
  31. Self-help groups consist of certain members who pool their savings and constitute a fund which is further used in making finance and advances to other members. This helps to reduce the functioning of informal sectors of credit.
  32. After a year, if such a group is regular in its savings, it becomes eligible for availing loan from the bank. Such loans create employment opportunities.
  33. SHGs are becoming popular because they help borrowers overcome the problem of lack of collateral. They can get timely loans for variety of purposes and at a reasonable interest rate. They help women to become self-reliant.

Words that Matter

  1. Medium of exchange: Money acts as an intermediate in the exchange process.
  2. Double coincidence of wants: When in the exchange, both parties agree to sell and buy each other’s commodities it is known as double coincidence of wants.
  3. Currency: Modern forms of money like paper notes and coins.
  4. Demand deposits: The deposits in the bank accounts can be withdrawn on demand, these deposits are called demand deposits.
  5. Cheque: It is a paper instructing the bank to pay a specific amount from the person’s account to the person in whose name the cheque has been issued.
  6. Credit: The term refers to an agreement in which lender supplies the borrowers with money, goods and services in return for the promise of future payments.
  7. Debt-trap: At times repayment of the loan becomes difficult and credit instead of improving the earnings, pushes the borrower into a situation from which recovery is very difficult and painful. This situation is called debt-trap.
  8. Collateral: It is an asset that the borrower owns such as land, building, vehicle, live stocks and deposits with banks and uses this as a guarantee to a lender until the loan is repaid.
  9. Depositor: Person who deposits money in the bank.
  10. Borrowers: People who takes loans from the bank.
  11. Lender: A person who gives money to a borrower.
  12. Reserve Bank of India: The supreme institution of the financial system.
  13. Formal sector loans: Loans from banks and cooperatives.
  14. Informal sector loans: Loans taken from money lenders, traders, relatives and friends.
  15. SHGs: Self-help groups consist of certain members who pool their savings and constitute a fund which is further used in making finance and advances to other members.

I. MULTIPLE CHOICE QUESTIONS

Choose correct option:

1. Who supervises the functioning of formal source of loans?

(a) Reserve Bank of India                                                       (b) State Bank of India

(c) Central Bank of India                                                        (d) Informal money lenders.

2. What portions of bank deposits are kept by the banks for day to day transactions?

(a) 11% of the deposits                                                           (b) 15% of the deposits

(c) 18% of the deposits                                                           (d) 17% of the deposits.

3. When does credit play a positive role?

(a) When the loan repayment is not done on time but profits are made.

(b) When neither loan repayment is done on time nor are profits made.

(c) When the loan repayment is done on time and profits are made.

(d) None of the above.

4. Why is money called the medium of exchange?

(a) Goods are being bought and sold with the use of money.

(b) Use of money has made things easier to exchange.

(c) Money acts as an intermediate in the exchange process.

(d) Without exchange of money nobody can fulfil his all needs and requirements.

5. In India which type of currency is widely accepted as a medium of exchange?

(a) Rupee                                                                                 (b) Dollar

(c) Shilling                                                                               (d) Taka.

6. Modern form of money is linked with which system?

(a) Accounts system                                                                (b) Finance system

(c) Banking system                                                                 (d) None of the above.

7. What are electronic banking services?

(a) ATM                                                                                  (b) Debit Card

(c) Credit Card                                                                        (d) All of the above.

8. What do people belonging to poor households lack?

(a) Proper document                                                               (b) Collateral

(c) Certificate of earning                                                         (d) All of the above.

9. Currency notes in India are issued by the ...... .

(a) State Bank of India                                                           (b) Reserve Bank of India

(c) Central Bank of India                                                        (d) None of the above.

10. Which one of the following does not come under terms of credit?

(a) Interest rate                                                                        (b) Employment

(c) Collateral                                                                           (d) Mode of repayment.

II. VERY SHORT ANSWER TYPE QUESTIONS

  1. What is the meaning of ‘barter system’? (CBSE 2015)
  2. Give the reason why transactions are made in money.
  3. What is known as double coincidence of wants?
  4. What is it that can act as a medium of exchange in transactions?
  5. Name two objects that were used as money before the introduction of coins.
  6. What are the modern forms of money?
  7. What is the chief feature of the modern currency?
  8. What do people do with extra money?
  9. Why do we consider demand deposits as money?
  10. Why deposits in the banks are called demand deposits?
  11. What is the major source of revenue for the commercial banks?
  12. What do banks do with the money we deposit there?
  13. Why do people in rural areas demand for credit?
  14. Why did Swapna sell a portion of her land?
  15. What would the lender do in case the borrower fails to repay the loan?
  16. Why do lender ask for collateral while lending?
  17. Give some common examples of collateral used for borrowing.
  18. While taking a loan, borrowers look for easy terms of credit. What do is this mean?
  19. Why did Salim need credit?
  20. Why did Swapna need credit?
  21. People obtain loans from various sources. Name them.
  22. How do the informal lenders take undue advantage of the borrower’s helplessness?
  23. What does higher cost of borrowing means?
  24. When is crucial for the country’s development?
  25. What is necessary to reduce the dependence on informal sources of credit in rural areas?
  26. Which segment of the society receives formal credit?
  27. Which segment of the society depends on the formal sources?
  28. Mention one of the major reasons which prevents the poor from getting bank loans.
  29. What are the difficulties from which the barter system of exchange suffers?
  30. What are the benefits that you can get by depositing your extra money in the banks?
  31. How do the SHGs help borrowers?

III. SHORT ANSWER TYPE QUESTIONS

1.      Why is it necessary for the banks and cooperative societies to increase their lending facilities in rural areas? Explain.                                                                                                           (CBSE 2015)

2.      What does credit mean? What are the terms of the credit?

3.      Why are transactions made in money? Explain with suitable examples.                    (CBSE 2009

4.      Why is the rupee widely accepted as a medium of exchange?

5.      Explain any two features each of formal sector loans and informal sector loans. (AI CBSE 2009, CBSE 2011)

6.      What is the role played by the banks in the economic development of a country?    (HOTS)

7.      Study the diagram given below and answer the following questions:

(i) Which are the two major sources of credit for rural households in India?

(ii) Which one of them is the most dominant sources of credit for rural households?

(iii) Why is it the most dominant source of credit? Give two reasons.  (CBSE 2008)

1.      What are the drawbacks of informal sources of credit?

2.      How is the facility of cheque useful?

3.      Why are the deposits in the banks called ‘demand deposits’? What are the benefits of deposits with the banks?  [CBSE 2010(F)]

4.      What is credit? What is its importance? [AI CBSE 2013(C)]

5.      What is money? Why is modern money currency accepted as a medium of exchange? (AI CBSE 2012)

Or

‘The rupee is widely accepted as a medium of exchange’. Explain. (CBSE 2008, 2012, 2013)

6.      Why is cheap and affordable credit important for the country’s development? Explain three reasons. (AI CBSE 2012)

7.      “Whether credit would be useful or wet, it depends on the situations”. Give two different examples in support of this statement. [CBSE 2012(F)]

8.      “Most of the poor households still depend on the informal sector for loans, both in rural and urban areas of India”. Support the statement with three examples.   [CBSE 2012(F)]

9.      What are demand deposits? What are their advantages?  (CBSE 2012)

10.  Which government body supervises the functioning of formal sources of loans in India? Explain its functioning. (AI CBSE 2012)

Or

11.  Who supervises the functioning of banks? In what ways is the supervision done? [CBSE 2009(F), 2012]

12.  Mention three limitations of the barter system. (CBSE 2008)

 

IV. LONG ANSWER TYPE QUESTIONS

1.      How does the use of money make exchange of things easier? Explain with examples. [CBSE 2010

2.      What is the role of SHGs? What are the reasons of its growing popularity?  (HOTS)

Or

What are Self-Help Groups? Describe, in brief, their functioning.  (AI CBSE 2009)

3.      Throw light on the various sectors of the economy.

4.      Differentiate between formal and informal sources of credit. Explain problems faced by borrowers of loan from informal sources. [AI CBSE 2013(C)]

5.      Which government body supervises the functioning of formal sources of loans in India? Explain its functioning. (CBSE 2012)

6.      What are the two categories of sources of credit? Mention four features of each. (CBSE 2013)

7.      What is credit? Why is there a need for credit in rural areas? (CBSE 2011)

8.      What is the idea behind forming the Self Help Groups or the SHGs? Explain the functioning of the Self Help Group or the SHGs?  [CBSE 2008, 2009(O)]

9.      Why should the banks and cooperatives societies provide more loan facilities to the rural households in India? Give four reasons.  (CBSE 2008, 2012)

 

V. VALUE BASED QUESTIONS

1.      Grameen Bank of Bangladesh has done a great job in the rural areas of the country. Which values according to you is it able to support?

2.      What according to you can reduce the dependence of the poor households on informal sources of credit? Suggest ways to avert this situation.

TEST YOUR SKILLS

1.      What are bank deposits? What are its benefits?

2.      Explain the concept of loan activities in bank.

3.      Explain with two examples, two different credit situations one-positive and onenegative.

4.      What are the two sources of credit? How does RBI control banks?

5.      What is double co-incidence of wants?

6.      In situations of high risks, credit might create further problems for the borrowers. Explain.